August 30th: A Look Ahead

Since our June 8th newsletter, Anticipate the Ball, a lot has happened in our economy. In this letter I would like to discuss the import of some of the national/international news in terms of how it affects your portfolio and cover our insights on what we expect in the months and years ahead. Spectrum Financial Alliance is a concentrated asset manager that attempts to acquire undervalued positions, with strong downside protection, that are likely to outperform in the specific market environment we envision ahead. So, my statements in this letter are forward looking. While we know that no one can divine the future, we can draw reasonable conclusions on how world and national events are likely to play out. We have had a high degree of success in this area in the past.[1] We have attached on the following page data calculated by Morningstar Inc. showing the influence past projections have had on SFA’s accounts in comparison to the market. On September 16, 2016, SFA released a newsletter predicting that Donald Trump would win the Presidency by a large margin. We were right! By positioning client portfolios to take advantage of Trump’s policies, Spectrum Financial Alliance has beaten the market handily since the election. The graph above represents SFA’s performance compared to the S&P 500 from the 2016 Election (11/9/16) to yesterday’s close (8/29/18)On February 12, 2016, SFA released a newsletter predicting that the market had bottomed out and encouraging our clients to take advantage of the growth opportunity ahead. The result of this correct prediction has seen tremendous gains in the portfolio values of our clients! This graph represents SFA’s performance compared to the S&P 500 from the exact market bottom date predicted by SFA (2/12/16) through yesterday’s close (8/29/18)

Politics

So now, let me give you some reasonable projections going forward on the national and international scene, as to how outcomes will likely occur in a way that benefits our country, our fellow citizens, and your investments. Much of the media speculation (that has increased market volatility) relates to a feared reversal of the tax legislation from December of 2017 should Democrats recapture the US House of Representatives in the November 2018 elections. Midterm elections are always tricky. Traditionally, the President’s party loses a significant number of seats and Congress shifts control to the other party. If you are listening to political pundits, the vast majority of liberal and conservative commentators are telling us to absolutely expect a shift to a Democratic majority house and Speaker Pelosi. Our opinion strongly differs because of the tremendous success economically, and culturally, of this administration’s initiatives. We believe we will continue to see well above average economic growth, and equity market performance, leading up to, and through, the midterm elections in November. People vote their pocketbooks and success! This should skew the normal political outcome back to President Trump’s party, the Republicans. We believe that there may be a few seats lost in the House, due to the sheer number of Republican seats now in play, but we strongly believe that the House will remain in conservative hands. A good example of how this is likely to occur is to look at the last twelve special elections that have been held, noting that in eleven of the twelve, Republicans prevailed. President Trump has proven that his endorsement of a political candidacy is incredibly important in moving poll numbers and shifting election returns. This highly energetic man will be working very hard between now and the November elections to move those polling dials. In the US Senate, it is a slightly different result. Currently, Republicans control 51 seats in the Senate with Democrats holding 49. However, one of the Republican seats, recently deceased Senator John McCain’s, is in play. That brings our margin down to 50 to 49. Utilizing this very slim margin, the US Senate Majority Leader, Senator Mitch McConnell from Kentucky, has done a masterful job (in my opinion) in guiding major victories in the federal judiciary appointment process and in the tax bill last year. He has also championed and successfully led efforts to continue the deregulation process following decades of overburdening regulations that hamstrung our nation’s economic growth and hurt our workers’ job growth. Our view is that given the demographics and location of the US Senate races this year, Republicans are very likely to gain another 3-4 seats in the US Senate, at a minimum. This will further solidify conservative control in that chamber and provide even more momentum to reverse the decades of activist federal judges who have undermined not only federal laws, but our Constitution itself. This will also break the log jam of presidential appointments that have languished under the small Senate majority held by conservatives. These two outcomes, retaining U.S. House control and increasing conservatives’ advantage in the U.S. Senate, as well as the increasing recognition that the status quo of politician indifference is no longer tolerable to the American people, will lead to the advancement of conservative principles and economic progress during the last two years of President Trump’s first term (yes – we believe President Trump will overwhelmingly win a second term!). This will allow the advancement of a national infrastructure bill, a bill that has been held up by both political indifference and government bureaucracy. That infrastructure project will come in funded, we believe, at approximately $1 trillion dollars and provide significant productivity gains by improving our nation’s roads, bridges, dams, and waterways. As I have stated in the past, I believe this will be a private-public partnership with as little as one quarter of the total sum being paid for by the federal government. This type of infrastructure spending could be done in a three to four-year process and would provide an even greater jumpstart to our economy than the tax changes did after their passage in December of 2017. Final Analysis? Conservatives hold the U.S. House, increase their majority in the U.S. Senate, President Trump wins a second term by a large electoral margin, Congress passes legitimate immigration reform, and the U.S Builds That Wall! ALL. VERY. LIKELY!

No Trade War, but Definitely Trade Disputes

As we have all read and heard for the entire term of this President’s time in office, there are significant differences pertaining to our nation’s trade policies. Our view is very clear. Our nation over the last forty years, under both Democrat and Republican presidents, has literally given away our inherent trade advantages to China, the European Union, Canada, Mexico, and many other nations. This perversion of free trade philosophy into government manipulated trade has devastated our nation’s middle class, eliminated their real income growth over the last seventeen years, and literally shipped our children and grandchildren’s jobs overseas. The current administration knows all of this to be factually true as our President has conducted international business with all of these countries while a private citizen. President Trump also knows well the negative impact our government’s policies have on the ability for American businesses to expand around the world and the limitations placed on advancing our exports by each of these countries. The talk of trade wars is way overblown. We certainly have trade disputes with many nations, but they are disputes created by decades of unfairness and inequity in the application of free trade. For example, a car imported from Germany pays a 2.5% custom tax to the US government while a car we export to Germany is taxed at 10%. Why?? Is that free and fair trade? While we are dealing with trade disparities, we also have to deal with Chinese overt theft of our intellectual property, our defense secrets, and our trade secrets. The Chinese basically do not have to spend a lot for research and development because they steal what they want to have. They steal defense secrets and American manufacturing technology. They force companies that want to build/sell in China to employ Chinese nationals who work with American technology and then steal it over time. This has been going on for many decades and it undermines American innovation and technological advancement as previous presidential administrations have never confronted this lawless behavior. This administration has elected to confront. It also elected to confront the unfair trade tariffs placed on the United States by the European Union and its partners. Whether a small faction of our country likes it or not, we are still, by far, the fastest growing and most dynamic economy on the face of Earth. We should have never tolerated unequitable and unfair trade policies that disadvantaged our country to the extent that they caused a huge loss in national income, a loss in American workers’ pay, and huge losses of American jobs! Many of these negative results were paid for by funneled political contributions to American politicians. The uproar in Washington and around the globe that we hear daily is the death cry of a status quo that too often took advantage of American generosity while reducing our nation’s middle class to a mere afterthought in American diplomacy. We project that the majority of these trade disputes will be settled almost wholly over the next six to nine months. Some, like Canada, may dig their heels in a little harder, but ultimately, they do need us much more than we need them, and their trade policies will be changed. The end result of the settlement of these trade disputes will be a much more vibrant expansive manufacturing sector where higher wages will be paid to American workers. This will continue to provide more jobs than there are job seekers, which will force corporations, without government legislation or bureaucratic interference, to raise the pace of wage growth (minimum wage) to attract additional workers – including those that are sitting on the sidelines debating whether to get off of government support to create a better life for themselves and their families.

Benefits of Tax Cuts

It was only January 1st of this year that the tax cuts from December officially began. However, the tax package that passed in December 2017 takes many months to begin to actually affect our nation’s large economy. The same could be said to be true of the rationalization of national regulation that is occurring even while you read this letter. Overregulation has been discussed for decades in our country while bureaucrats continued to hammer industries that they felt needed more “attention”. They hamstrung, bankrupted, and destroyed whole industries and all the jobs that were associated with them. As opposed to this heavy-handed government picking of winners and losers that we saw at its zenith during the Obama years, a Trump administration has elected to pursue a more rational regulatory policy, much to the chagrin of the “government knows best crowd”, and those changes, like the tax cuts, take a minimum of six to nine months to begin to be reflected in national income growth, corporate earnings growth, etc. So now, we are really just starting to feel the effects of these ongoing, positive economic policy changes. It is our belief that our nation has embarked, from January 2017, on what will be by far the longest period of uninterrupted economic growth in our nation’s history. The previous administration told us, both through President Obama and his Treasury secretaries, that our economy was permanently range bound in economic growth at under 2% per year. The Trump administration has targeted 3% economic growth and we believe that we will actually see 4% or higher economic growth soon. In fact, we project that we are going to see 4%, 5% and, likely at some point in the next four to five years, a 6% annual Gross Domestic Product growth rate. During President Reagan’s terms, which used many of the same policy tools that President Trump has enacted, we had 6% GDP growth in two out of his eight years. Each extra percentage point of growth equates to millions of additional American jobs. This growth will create expanding national income, an increase in wages and salaries as well as benefits for American workers, and higher inflation. Higher inflation is accompanied by higher interest rates. Higher inflation and interest rates will actually reduce the asset values of bond holders of all types. This is why our investment models do not contain traditional bond elements.Higher interest rates and inflation also tend to accompany rising equity values.So, to sum up this section, our economy is returning to a market driven, capitalist model that should provide, in our view, annual returns that are likely to exceed normal averages for an extended period of time. That means many years! These returns are driven by economic growth that cannot just be turned on and off at someone’s will. It is produced by policy changes made by our current Presidential administration and by our Congress.

Emotions and Hedging

There certainly is an emotional component to investing. One of our main jobs is to take emotion out of the equation. Our job is to not let it interfere with rational thought and to strive to apply sound investment practices and principles to give you the best result with a minimum amount of volatility or up-and-down movement. So, let me cover how we have handled things since the beginning of the second half of this year where we have previously stated that we believe the majority of this year’s returns will be generated. Since July 1st of 2018 and through August 29th, the firm’s annualized rate of return, net of all client costs, is 10.79%* versus the S&P 500’s return of ­­­­­­6.59%*. This large beat of the market’s returns, in our view, was predictable because of how your portfolio is structured. For example, our heaviest, most over-weighted sector is banking. The bank stocks we own are well-managed, highly downside resistant, and driven by continuing increases by our nation’s Federal Reserve of the Fed Funds rate. You are likely to see another Fed Funds rate hike, after two already this year, in mid-September. As the Fed Funds rate goes up, banks raise their rates at a faster clip, thereby raising their net interest margin. This means that every time the Fed raises rates, which we believe they will next month, you should see your bank stock values react to that increase in a positive way. The bank sector, in our opinion, is also heavily over-capitalized. Under this administration, handcuffs are being taken off banking so that loans can be made with their excess capital aiding the continuing expansion of American businesses. This increase in the availability of capital to businesses will unquestionably lead to more growth in jobs and higher wages!

Protecting You on Market Declines

Let me mention a couple of things we have done recently that represent true hedges in your portfolio. In the past six weeks or so, we have taken several actions to preserve and enhance your account values by minimizing your downside and enhancing your upside returns. On July 11th of this year, following a decline that occurred in our Citigroup stock values, we bought a covered call in many of our client accounts that would allow us to purchase Citigroup at a value of $70 per share between July 11th and September 21st when that call option would have expired. Our cost for that call option was $1.78 per share. On August 6th, three weeks later, rationality was restored in the price of Citigroup stock (it went up) and we sold the covered call at $3.50 per share. This provided our clients an approximate 95.4%* return in this three-week holding period. Promptly after the sale of our covered call, on August 8th, the price of a share of Citigroup fell from $73 per share to $68.57. The point of discussion in these transactions is that the market is providing us great opportunities every time fear rears its ugly head. We practice rational investment policy that capitalizes on that fear and uses it to your portfolio’s advantage. Another example of a pure hedge was our August 9th buy of TVIX. TVIX is an S&P 500 Inverse Leveraged ETF, which means that when the market is a little toppy, or a little too high, TVIX gives us an opportunity to protect your whole portfolio without selling highly appreciated portfolio elements that we believe are likely to perform well long term. So, on August 9th we bought TVIX at $31.18 per share believing that, again, there was likely to be very short-term weakness due to overly fearful consideration of a trade war. Exactly 6 days later we sold all of the acquired shares as the market bottomed out and our net profit was 32.7%*. Our firm’s TVIX buy and sell points reflect excellent anticipation, but more importantly, reflect a way to protect your portfolio, even in small market down drafts. It does not mean we can prevent all declines and I assure you that we will not. However, it does mean that we are very attuned to investment tools that allow us to both smooth your ride, minimize your downside, and increase your upside gains. This is our mission; we are serious about it. We love having the opportunity to lead it for you!

Summary

In summary, the months ahead contain a world of opportunity for us as investors to realize incredible benefits from our equity markets. More importantly, they contain a world of opportunity for our country to advance a free and fair-trade policy that does not involve sacrificing our nation’s middle-class jobs on the alter of political expediency or political correctness. Everyone I know wants our nation to provide jobs for its citizens and a safe environment for us all to live in. However, many disagree on how to get there. We are applying conservative economic principles, and outlook, to the investment management of your precious funds because that is what works long term! It has saddened me for at least ten years to see how politics has become embedded in the investment world. Maybe I just woke up and it really was always that way. We believe in the exceptionalism that is America and in productive activities, not overdoing leisure pursuits like entertainment, sports, or politics where we seem to find our nation’s elites doing their best to undermine our nation’s values, character, and its historical greatness. Because of the opportunities I, some of my coworkers, and many of you, have been given to serve this great nation, we fully understand the tremendous privilege it is to be born in America. We believe in the leadership direction of President Trump and the capacity his tremendous cabinet has to restore America’s beacon of freedom to its rightful place among nations – instead of an also ran that is ashamed of its heritage and greatness. I hope this letter provides you some additional insight into our expectations going into the next six to nine months. I also hope you understand that we do not believe this is a short, or even intermediate term, event. There are going to be massive changes in our national policies and the emergence of a much more freedom loving and tolerant international community. America will lead not only our nation back to economic growth and prominence, but very likely to pull the rest of the world along with us – enhancing their standard of living and leading to more brokered peace agreements and a lot less military conflict. This should result in a great long-term investment climate that produces higher than normal returns for many years! I appreciate the leadership that our nation’s President is providing and admire the courage shown not only by President Trump, but by every one of his cabinet officials and highly appointed officials who have done an awesome job under the most vile conditions. God bless our country and God bless every one of you. As always, thank you so much for the opportunity you have given us to manage your money and to create a better future for your family. That is our mission and we are always going to do our best to accomplish it.

*Spectrum Financial Alliance, Ltd., L.L.C is a Registered Investment Advisor. This letter contains information that is not suitable for everyone and should not be construed as personalized investment advice. Past performance is no guarantee of future results and there is no guarantee that the views and opinions expressed in this letter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Please contact our office at 859-223-6333 or 800-799-5333 with any questions or for further information.

[1] An internal analysis of all SFA communications (letters and social media posts) reveals that since 1999, Kelly has made a number of written predictions regarding economic and political events. In the past 19 years, he has been correct in his predictions 69% of the time. Also, since 2009, proving that with age and experience comes wisdom 😊, 80% of Kelly’s predictions have been correct!